When to Pay a Bonus (and When Not To)

With oil bosses still receiving large cash bonuses despite the slump in commodity prices, the issue of high executive pay continues to antagonise investors, politicians and the public alike

Jermaine Haughton

There is a fine line between underrated CEOs and overpaid ones.

In the commodities sector, shareholders have recently made the headlines for rejecting the “excessive” compensation handed out to oil bosses.

In the biggest oil bust in decades, the price of crude oil has more than halved since 2014, from around $110 a barrel to below $50. Yet, executives took home tens of millions of pounds in bonuses for drilling in 2014, based on a compensation formula that links bonuses to companies finding more gas and oil than in the previous year.

As well as some shareholders asking companies to reduce connections between pay and production, investors have formed backlashes against industry giants Shell, BP and Nordic Oil, opposing rising pay packets for bosses.

Since the financial crisis at the end of the 2000s, high executive compensation has been a highly debated topic, especially in North America and European countries where median incomes have stagnated, unemployment has increased and government spending has been dented.

Employers argue that large compensation is needed to both attract and retain the best executives to drive growth in their company during an ever-competitive market, while many investors are worried that bosses are being overpaid for delivering little results, and risk alienating both their staff and the public.

Across all industries in the UK, the last 18 months has seen FTSE 100 companies losing votes on executive pay practices for the first time since 2012 - the tail end of the financial crisis - pitting shareholders at loggerheads with company boards about getting value for money from executive staff.

More recently, Barclays former chief executive Antony Jenkins has come under scrutiny, after it was revealed this month that he is set to receive a bonus of half a million pound taking his total remuneration to £3.4 million for 2015.

This is despite being ousted by his employers after just three years in charge, having lost the board’s confidence that he was capable of turning around the bank’s fortunes. Barclays reported a 2% drop in annual adjusted profit before tax in 2015 to £5.4 billion, lower than the £5.8 billion expected by investors.

The heightened dissent from boards, regulators and investors reflects a growing feeling that many underperforming managers are receiving pay that is too high, as shown in the CMI’s 2016 National Management Salary Survey.

The analysis of remuneration data for 105,000 managers and 425 organisations found that more than one in five managers (23%) who fell short of performance expectations in the last year still received bonus pay-outs on top of their basic salary.

The average underperforming manager who took home a bonus received an additional £4,270, or 12% of their basic pay, on average, taking their total remuneration packages to £40,067.

In total, 57% of managers received a bonus over the last 12 months, compared to 54% in the previous year.

The problem of rewarding managers for failure is even more acute at more senior levels, with 43% of senior managers who fall short of expectations still banking a bonus in the last 12 months. Meanwhile, C-suite executives continue to earn a substantially larger part of their pay in bonuses compared to managers.

On average, bonuses account for 38% of CEOs’ and directors’ remuneration – equivalent to £55,969.

“Pay and performance issues in the UK extend well beyond CEO level,” CMI chief executive Ann Francke said. “The truth is that bonuses continue to remain divorced from performance in too many organisations.

“Fixing the problem means setting clear targets, aligning bonus pay with performance, and being prepared to have difficult conversations with underperformers who don’t measure up.”

However, not all executive bonuses are necessarily undeserved, and are arguably a reward for good work by bosses in challenging circumstances is a good idea that encourages high performance again in the future.

Tesco chief executive Dave Lewis was paid £4.6m including a £3m bonus last year, a large sum for his leadership as he has helped stabilise the crisis-hit retailer and returned it to profit, following the accounting scandal and slumps in sales.

How, then, should you approach awarding bonuses to staff? Here are three key considerations:

Reflect on your Company goals

Ask yourself, what are your company’s objectives? What is your definition of poor, average and excellence criteria for your company? By deciding what you want to accomplish as a company, goals can then be set to departments and individuals so that every group and each employee is working toward shared objectives.

Keeping staff informed of goals is important as colleagues can provide invaluable feedback and insight into annual performance plans to help employees and employers achieve their goals.

Set Specific Goals with Employees

Targets such as “Do a better job” are not going to help your team or organisation, due to its vagueness and ambiguity. However, more specific and easily-measurable targets which tie in with the tasks the individual completes each day.

It could be to “reduce customer complaints by 50%” or to “find 50 new sales prospects a week.” Don't automatically assume that bonuses should be tied to increased sales or even profitability. For example, it may be most important in a given year for your business to cut costs or raise visibility.

Tie bonuses into that critical goal rather than one that is traditional.

Apply an Affordable Bonus Structure

Most importantly, can your organisation afford to give bonuses? Not all companies can, and bosses should sit down with their finance and HR teams and work out what the impact bonuses could have on their bottom line.

There are no hard and fast rules except that you should make bonuses equitable among peer groups and always have performance justification for bonuses.

Some companies reward staff with a share of profits, others by giving them back a percentage of their wage, and a growing number of firms are trialling newer methods, such as extended annual leave and other incentives.

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